9 Smart Exit Strategies for Real Estate Investors
Even though the information on this web page is provided by a qualified industry expert, it should not be considered as legal, tax, financial or investment advice. Since every individual’s situation is unique, a qualified professional should be consulted before making financial decisions.
In this article, I will provide a definition and example of an exit strategy in real estate investing.
Then, I will describe 9 exit strategies that you can use in your real estate investing business. Some of them are creative, overlooked, and uncommon.
Let’s start with the definition.
What Is an Exit Strategy in Real Estate?
Simply put, a real estate exit strategy involves removing your capital from an investment.
The preferred exit strategies in real estate are the ones that are done on your schedule and under the most beneficial financial conditions.
A lot of times, however, investors have no choice but to employ an exit strategy that makes the best of a less than ideal situation.
Real Estate Exit Strategy Example
Let’s say that an investor buys a small multi-tenant strip shopping center. The tenants are small local businesses, and the property is bought for a modest price.
The investor recruits well-known tenants that are stronger financially. This increases the value of the property. The investor then sells the property for a profit.
The investor’s exit strategy was to sell the property after adding value to it.
1. Selling the Property
The most common component of a property investment exit strategy is the sale of the property.
Short-term investors such as house flippers sell their properties immediately after improving them. The faster they are able to sell the property, the higher their returns are.
Their chances for profitability will increase by a thorough inspection of the property prior to purchase. An accurate estimate of the property’s condition will help them stay on budget and, just as importantly, on schedule.
Long-term investors create ongoing income from leases knowing that those returns will be improved by the eventual sale of the property.
Whether they wind up selling the investment property on schedule down the road or they have to sell more quickly, the value of the property will be impacted by its condition and tenant occupancy.
This requires holding adequate reserves for maintenance and re-leasing. Long-term returns can also be enhanced by leveraging their funds with debt.
To sell your investment property, consider listing it on our marketplace for investment properties. It’s designed specially for real estate investors.
If your investment home has tenants in it, it may be interesting to many real estate investors using the marketplace to shop for rental properties in your location.
Debt is a tool, and it’s critical that you use the right tool for the job.
Hard money loans have higher interest rates and shorter terms and are suitable for short-term investment purchases.
If it turns out that you need/want to hold the property longer, you should refinance to a longer-term loan. These loans have lower rates and longer terms.
Note that a longer amortization term does more to reduce your payment than typical rate reductions.
A cash-out refinance will enable you to accomplish a partial exit strategy.
If you hold the property long enough and the market is good, you might even do multiple refinances over the years and remove all your capital.
3. Doing a 1031 Exchange
In researching an appropriate property investment exit strategy, investors should learn about a 1031 Exchange.
A 1031 Exchange allows investors to defer tax on property sales proceeds by immediately reinvesting in similar assets.
A 1031 Exchange can help you to grow the quantity or the quality of your portfolio assets.
Say an asset has significantly grown in value. You can sell that property by using a 1031 Exchange, buy multiple investment properties with the proceeds, and defer taxes on the sale.
The reverse is also true. You can sell multiple properties in order to buy a larger property while deferring taxes.
If you still own the property upon your death, your beneficiaries may be able to take ownership of the property at its current value.
This is called a “stepped-up basis.” If the basis is the same as the current market value, there is no gain and, therefore, no tax.
It is possible to convert ordinary real estate assets to ownership in a REIT and become a passive investor, but it’s a long, multi-step process.
If you’re interested in this, you should work with experienced professionals called 1031 exchange qualified intermediaries.
To learn more about this procedure, read our guide to residential property 1031 exchange.
4. Creating a Trust
One of the often overlooked exit strategies for real estate investors is the use of a trust. When you place real estate in a trust, you no longer own the property.
As a beneficiary, you can benefit from the property, but it is owned by the trust.
Since you don’t own the property, your creditors cannot make claims or file liens on it. Offshore trusts are particularly good as protection against creditors.
Trusts established outside of the US are beyond the jurisdiction of US courts.
Properly structured by experienced trust attorneys, your heirs can become beneficiaries of the trust when you are gone. This gives you control over how your assets are passed on to your family and avoids probate.
5. Converting Real Estate into Self-Directed Brokerage Account Funds
Like other IRAs, any income or equity generated by real estate IRA or 401(k) assets isn’t taxable. You pay tax on the amounts that you eventually withdraw as you withdraw them.
In order to select the assets held by the plan, you’ll need to use a Self-Directed IRA.
This is considered an exit strategy because the real estate is now owned by the IRA as a custodian for the benefit of the plan participant (you).
You will not be allowed to participate in ongoing operations related to the assets, such as property management. You become a passive investor.
If you want to learn more, we have a detailed guide to investing 401(k) funds in real estate.
Wholesaling is one of the most popular real estate investment strategies.
However, it isn’t usually included in a list of real estate investment exit strategies. That’s because the wholesaler doesn’t invest anything beyond their time, earnest money, and possible due diligence fees.
However, if you consider that an exit strategy is the plan to finalize an investment activity that generates income, wholesaling qualifies.
A wholesaler finds a property that is likely to be desired by investors and enters a contract to buy that property. The contract must allow for an assignment of the right to buy the property.
Wholesalers must know how to market wholesale real estate deals to find a buyer before the deadline in the contract and avoid losing the earnest money.
Ideally, they need to build a cash buyers list for real estate wholesale deals beforehand, with potentially interested investors on it.
Once an investor who wants the property is located, the wholesaler assigns the contract and is paid a fee. That is the wholesaler’s exit strategy.
This strategy is popular with beginner real estate investors. If you are new to it, read our guide Wholesale Real Estate Investing Explained for Beginners.
7. Exiting a REIT Investment
One of the reasons that people invest in a publicly traded REIT is that they can easily access their funds by selling their shares.
These REITs are traded on the major stock exchanges allowing for a flexible exit strategy.
A non-traded REIT is very different. Non-traded REITs are long-term investment vehicles that should only be used by qualified, experienced real estate investors.
The proceeds from the sale of REIT shares are taxable, the same as other stocks or bonds. If you have held the shares for more than one year, they should qualify for long term capital gains treatment.
8. Exiting a Real Estate Investment Fund
Some real estate funds are publicly traded, and some are private. Publicly traded funds are basically mutual funds. Your participation can be ended based on your schedule and needs.
Some private funds are “closed-end” funds that dictate when investors can remove their capital.
This may be because the investment hasn’t reached the predetermined point in its lifecycle when it can be sold for the optimum return.
Your tax liability for gains made when your fund shares are sold or the project is completed will depend on how long you’ve held your interest in the fund.
Fund participation of more than one year should qualify your investment for long term capital gains treatment.
Investors should thoroughly research a real estate fund before investing.
In a real estate syndication, an entrepreneur (the sponsor) recruits investors for a real estate investment project. The sponsor handles all details of the investment while the investors stay passive.
Most syndications involve a long period of rental income followed by an eventual sale of the property, hopefully at an advantageous time.
However, “land bank” syndicates will hold vacant land until its appreciated value brings the project’s anticipated returns.
Syndications are almost always structured as an LLC or LP to reduce liability. Your ability to exit ahead of the project’s completion will depend on the operating or partnership agreement.
Other investors often have the right of first refusal and/or the right to approve new members. That could limit your list of potential buyers.